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Navigating Complex IRS Penalty Abatement Procedures for Failure-to-File, Failure-to-Pay, and Accuracy Related Penalties

WEDNESDAY , MAY 3, 2017, 1:00-2:50 pm Eastern

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FOR LIVE PROGRAM ONLY

May 3, 2017

Navigating Complex IRS Penalty Abatement Procedures

Joel N. Crouch, Managing Partner Meadows Collier Reed Cousins Crouch & Ungerman, Dallas jcrouch@meadowscollier.com Benjamin Peeler, J.D., CPA, LL.M., Partner Eide Bailly, Salt Lake City bpeeler@eidebailly.com Judi Smith The Law Office of Judi Smith, Peoria, Ariz. jsmith@judismithlaw.com

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

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May 2017 Benjamin J. Peeler, J.D., C.P.A., LL.M

Tax Controversy

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Mastering Procedural and Practical Ways to Obtain Penalty Abatement; Mitigating Harsh IRS Penalties

Navigating Complex IRS Penalty Abatement Procedures for Failure-to-File, Failure-to- Pay, and Accuracy Related Penalties

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Learning Objectives

• Discern the abatement process and documentation

requirements for various types of IRS penalty abatements

• Decide whether clients have sufficient grounds to abate

tax penalties for failure-to-file, failure-to-pay and accuracy-related penalties

• Identify very subjective reasonable cause criteria
• Recognize benefits of using “Office of Appeals”

effectively

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Civil Penalties Assessed and Abated, Fiscal Year 2016

• The IRS assessed $27.3 billion in civil penalties.

Approximately $12.1 billion was assessed in civil penalties on individual and estate and trust income tax returns

• The IRS abated $8.9 billion in civil penalties.

Approximately $3.8 billion was abated for civil penalties

• n individual and estate and trust income tax returns.

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Recent IRS pronouncements regarding penalties

• Effective with returns due after January 1,

2016, penalties for not filing correct information returns and/or not furnishing correct payee statements have increased and are now subject to inflationary adjustments.

• Examples of affected forms include: Forms 1098,

1099, W-2G and W-2.

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Penalty Handbook

• Penalties exist to encourage voluntary compliance

by supporting the standards of behavior required by the Internal Revenue Code.

• Voluntary compliance consists of preparing an

accurate return, filing it timely, and paying any tax due.

• To be fair and effective, penalties should be severe

enough to deter noncompliance, encourage noncompliant taxpayers to comply, be objectively proportioned to the offense, and be used as an

• pportunity to educate taxpayers and encourage

their future compliance.

• Penalty administration should ensure consistency,

accuracy, impartiality, and representation.

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Delinquency Penalties

• Failure To File – § 6651(a)(1)
• 5% per month up to 25%
• Failure To Pay – § 6651(a)(2)
• 0.5% per month up to 25%
• Failure To Deposit – § 6656
• 2% if the failure is less than 5 days
• 5% if the failure is 5-15 days
• 10% if the failure is more than 15 days
• Fraudulent failure to file – § 6651(f)
• 15% per month up to 75%
• Failure to File Information Returns - § 6721
• $50 per failure if corrected before 30 days, up to $500,000
• $100 per failure if corrected after day 31 but before August 1, up to $1,500,000
• The greater of $250 per failure if corrected after August 1, up to $3,000,000
• Intentional disregard of the filing requirements are penalized the greater of $500.00 per failure or 10 percent of

the aggregate amount of the items required to be reported correctly

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Penalties – abatement options

• FTF – 6651(a)(1) – First Time Penalty

Abatement

• FTP – 6651(a)(2) – First Time Penalty

Abatement

• FTD – 6656 – Reasonable Cause only
• FTF Information Returns – 6721 – Reasonable

Cause

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Failure to File & Failure to Pay Penalties (Sec. 6651)

• The IRS will automatically send your client a notice if

they detect any filing and/or payment delinquencies.

• Requesting penalty non-assertion is simply a proactive

approach to preventing the notice. It is recommended that you attach a penalty non-assertion request to the late-filed return/payment with a reasonable cause defense.

• Attach a reasonable cause explanation for

filing/paying late to the Form 1040 return when filed.

• If the IRS accepts the reasonable cause explanation, it will

not assess failure to file/failure to pay penalties.

• A taxpayer may instead wait until the IRS sends a

penalty notice to then explain his or her reasonable cause.

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Failure to File Correct Information Returns § 6721

• No penalty shall be imposed under this part with respect to any failure

if it is shown that such failure is due to reasonable cause and not to willful neglect. (§6724 Waiver; definitions and special rules)

• Filing responsibility can not be delegated but deceitful acts by employees

and/or processing vendors may constitute reasonable cause.

• Substantial Compliance:
• Overall the essence of the IRC section 6721 information return filing statute is to provide the

information needed for the IRS to ensure payees are properly reporting their income.

• A strict compliance to the filing of the form does not more or less inform the recipients of W-2

Forms of the amount of income they are to report and the reporting of the income to the IRS

• n their tax returns completes all the purposes of the statute. The IRS received the

appropriate information and tax payments as the statute seeks to support.

• FTA does not apply but the Service will look at compliance history in

their determination of intentional disregard and abatement.

• What corrective action took place to ensure timely filing in the future?
• Remember, filing responsibility can not be delegated so include any steps responsible person

takes to ensure timely filing in your abatement request.

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Penalties

• Do they apply?
• First time penalty abatement!!
• Internal Revenue Manual 20.1.1.3.6.1, FTF, FTP, Part
• Reasonable Cause Arguments – Various Statutes
• If the taxpayer exercised ordinary business care and

prudence and was nevertheless unable to comply or pay the tax, it will be considered due to reasonable

• cause. Treas. Reg. §301.6651-1(c)(1).

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Penalties, cont’d.

• Must be written statement under penalty of perjury

showing all facts supporting reasonable cause. Treas.

• Reg. §301.6651-1(c)(1). – RCA
• Always Appeal!!

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U.S. v. BOYLE, 469 U.S. 241 (1985)

• When an accountant or attorney advises a taxpayer on a matter
• f tax law, such as whether a liability exists, it is reasonable for

the taxpayer to rely on that advice. Most taxpayers are not competent to discern error in the substantive advice of an accountant or attorney. To require the taxpayer to challenge the attorney, to seek a "second opinion," or to try to monitor counsel

• n the provisions of the Code himself would nullify the very

purpose of seeking the advice of a presumed expert in the first

• place. "Ordinary business care and prudence" does not demand

such actions.

• By contrast, one does not have to be a tax expert to know that

tax returns have fixed filing dates and that taxes must be paid when they are due. In short, tax returns imply deadlines. Reliance by a lay person on a lawyer is of course common; but that reliance cannot function as a substitute for compliance with an unambiguous statute.

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Richard J. Meyer III v. Commissioner, TC Memo 2003-12, citing, Shaffer v. Commissioner, T.C. Memo 1994-618

• Courts have construed severe health problems

and mental conditions as facts and circumstances amounting to reasonable cause for failure to file, pay and make estimated tax payments.

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• G. Kierstead Family Holdings Trust v. Commissioner, T.C. Memo

2007-158, aff'd, 103 AFTR2d 2119 (9th Cir. 2009)

• Competence requires that the advisor be

competent on the specific tax matter and more complicated issues require more knowledge.

• Treas. Reg. § 1.6664-4(c) (1) and (taxpayer's

CPA who was “comfortable” with area was not sufficient absent proof of his qualifications as tax expert).

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Estate of Hake v. U.S., No. 1:15-CV-1382 (M.D. Pa. 2/10/17)

• The undisputed facts of this case indicate that the executors were endeavoring

to exercise care in the administration of the estate, and relied upon the advice

• f counsel to aid them in that effort. These facts reflect that the executors

applied for an extension of the payment and filing deadlines, in accordance with the advice of counsel. This advice and the executors' reliance on it was eminently reasonable and prudent under the circumstances, where inexperienced executors were buffeted by and contending with intra-family disputes over asset valuations and other matters that hampered their ability to fulfill their legal obligations. Moreover, nothing in the record remotely suggests that the executors were cavalier in their attention to the tax rules, or were seeking to do anything other than ensure that the estate paid its taxes faithfully.

• The record thus strongly supports the executors' assertion that they reasonably

relied upon the advice of their legal counsel, and that they took the steps they reasonably believed were required of them to pay the estate's taxes and file its return in accordance with the law. On these undisputed facts, we find that the executors exercised ordinary business care and prudence in relying upon their counsel's erroneous assertion that the deadline for filing the return and paying the taxes owed had been extended for 12 months, and the Court is not persuaded that Boyle or other binding authority compel a contrary finding.

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Penalty Appeals

• In the 2016 fiscal year Appeals received

114,362 cases and closed 111,345 cases.

• Appeals received 10,716 penalty appeal cases

and closed 10,079 penalty appeal cases.

Type of case Cases received Cases closed Cases pending as

• f 09/30/2016

Total Cases 114,362 111,345 55,284 Penalty appeals cases 10,716 10,079 4,069

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Penalty Abatement Denial Appeal

• In most cases the IRS will deny penalties that

are not eligible for First Time Penalty Abatement

• The IRS will issue a denial letter (LTR 854C)

granting appeal rights with specific filing instructions.

• The denial letter will list the specific reasons for

denial, address each item in the Appeal.

• Appeals must be submitted within 60 days of

the date of the denial letter.

• It is recommend the Appeal be submitted by certified

mail.

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Benjamin J. Peeler

Partner, Tax Controversy and Procedure

• Benjamin J. Peeler , J.D., CPA, LL.M.

Partner, Tax Controversy and Procedure 801.456.5476 | bpeeler@eidebailly.com Knowledge and Experience

 More than 17 years of tax experience specializing in federal tax, controversy and procedure.  Works with clients in the controversy areas relating to income tax, estate and gift tax, property tax, employment tax and other various tax matters.  Represents cli ents before the IRS in examination, Appeals, collection, penalty abatement, audit reconsideration, interest abatement and interest netting.  Represented the IRS before the United States Tax Court in large and specially designated tax cases, and in litigation before the federal district court as a special assistant to the United States Attorney.  Worked as an attorney for the IRS Office of Chief

• Counsel. Also, led and instructed groups of attorneys,

revenue agents and revenue officers through various procedures.  Leads Eide Bailly's IRS Practices & Procedures as a federal tax, controversy and procedure specialist.  Member of Eide Bailly’s National T ax Office team; committed to helping clients stay informed about tax news, developments and trends.

Professional Memberships

 AICPA  UACPA

Designations & Licensures

 Texas Bar, member  Certified Public Accountant, Texas  California Bar, member

Education

 LL. M., Taxation – Golden Gate University School of Law  Juris Doctor – University of California, Hastings College of the Law, San Francisco  Bachelor of Science, Accounting – University of Utah

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Joel N. Crouch

Managing Partner

• Mr. Crouch is Managing Partner of Meadows, Collier, Reed, Cousins, Crouch &

Ungerman, L.L.P. He represents a broad range of clients, including individual taxpayers, closely-held business enterprises, estates, corporations and tax advisors in all stages of federal civil and criminal tax proceedings. In almost 30 years of practice, he has helped his clients resolve hundreds of civil and criminal tax matters, many of which involved sophisticated and complex legal and tax issues, both domestic and international.

• Mr. Crouch is board certified in tax law by the Texas Board of Legal Specialization and

has been recognized as one of the best in his field by Texas Monthly and Law and Politics Magazines by being named a Texas Super Lawyer from 2003 through 2015. He has also been named one of the Best Lawyers in Dallas by D Magazine for the year 2012-2015 and he has also been named to Best Lawyers in America for Tax Law in 2015. In October 2013, he was recognized as a Top Rated Lawyer in White Collar Criminal Defense Law by ALM as published in The American Lawyer, Corporate Counsel and The National Law Journal. He is a frequent speaker on both substantive and procedural tax issues for both legal and accounting professionals. Topics include Tax Shelter Defense, IRS Examinations, Appeals, Litigation and Collection Strategies, IRS Criminal Investigations, IRS Offshore Activities, IRS Focus on Tax Professionals, Employment Classification, IRS penalties, and Litigating Partnership Tax Cases. Mr. Crouch has published various articles re: the IRS & tax procedures.

phone (214) 744-3700 toll-free (800) 451-0093 fax (214) 747-3732 jcrouch@meadowscollier.com

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Estimated Tax Penalties

• Pursuant to IRC Section 6654 a taxpayer who

does not pay enough tax, either through withholding or by making timely estimated tax payments, will have underpaid his or her estimated tax and may have to pay a penalty.

• The penalty is computed by applying the interest

rate for tax underpayments from the date the amount was due to the date of payment.

• Payment date is the postmark if mailed, or date
• f electronic payment.

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When is a Penalty Due

A taxpayer will owe a penalty for any payment period for which estimated payments plus withholding for the period and overpayments applied from previous periods was less than the smaller if:

• 1. 22.5% of the current year tax, ie, 90% of total tax

due; or

• 2. 25% of the prior year tax, ie, 100% of prior year

tax. For higher income taxpayers, substitute 27.5% for 25%, ie, 110% of the prior year tax.

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Penalty Figured Separately for Each Period

Because the penalty is figured separately for each payment period, a taxpayer may owe a penalty for an earlier payment period even if the taxpayer paid enough to make up the underpayment. This is true even if the taxpayer is due a refund when the income tax return is filed.

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Example

• Taxpayer thought he had enough withholding and did not

make estimated tax payments for 2016.

• In January 2017, the taxpayer made an estimate of his total

2016 tax and realized his withholding was $2,000 short to avoid the penalty.

• The taxpayer makes a $3,000 estimated tax payment on

1/10/17 to cover the tax due for 2016.

• After completing his return, the taxpayer is due a $50

refund.

• The taxpayer will not owe a penalty for the payment due on

1/17/17.

• The taxpayer may owe a penalty through 1/10/17 for

underpayments for the earlier payment periods.

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When a Penalty Is Not Due

• The total withholding and timely estimated tax payments was

at least 100% of the prior year taxes.

– Substitute 66 2/3% for 90% if at least two-thirds of gross income for the current or prior year is from farming or fishing.

• The taxpayer paid at least 90% of the total tax due, and paid

all required estimated tax payments on time.

– If AGI for the prior year was more than $150,000 ($75,000 if the current year filing status is married filing a separate return) substitute 110% for 100%.

• The taxpayer total tax minus withholding is less than $1,000.
• The taxpayer did not have a tax liability for the prior tax year

and was a citizen or resident of the U.S. throughout the prior year.

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Waiver of Penalty

The IRS can waive the penalty for underpayment if either of the following apply:

• 1. The taxpayer did not make a payment because of a

casualty, disaster, or other unusual circumstances and it would be “against equity and good conscience” to impose the penalty.

• 2. The taxpayer retired (after reaching age 62) or

became disabled during the prior or current year and met the following requirements: a) The taxpayer had a reasonable cause for not making the payment; and b) The underpayment was not due to willful neglect.

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Waiver of Penalty

• The estimated tax penalty cannot be removed or

waived for reasonable cause alone.

• The estimated tax penalty generally is not

waived as a result of disaster.

– In the case of a federally declared disaster area, "the Secretary may specify a period of up to one year that may be disregarded" in determining whether or not estimated tax payments were paid on time. – In these cases the IRS will issue a memo with specific instructions regarding the payment of estimated tax in the affected area.

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Waiver of Penalty

• If the IRS determines that a taxpayer was affected by a federally declared

disaster area, IRC 7508A provides that the IRS may specify a period of up to one year that may be disregarded both in determining whether a required action was performed in a timely manner, and in determining the amount of penalty or interest to be charged.

• The determination made by the IRS of who was affected, and the period

specified to be disregarded, are published by public notices and news

• releases. The information can be found on the IRS website using search

key "disaster tax relief."

• The following taxpayers also qualify for penalty relief due to federally

declared disaster areas and may call the IRS disaster hotline at 1-866-562- 5227 to request that relief: – Taxpayers whose books, records, or responsible tax professional are located within a disaster area, while the taxpayer's business (or residence in the case of individuals) is not. – Relief workers affiliated with a recognized government or charitable

• rganization assisting in the relief activities in a covered disaster area.

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How to Request a Waiver

• The taxpayer files a Form 2210 with the tax return

and attaches a statement explaining the reasons he was unable to make the payments.

• If the waiver is due to retirement or disability, attach

documentation showing the retirement date and age

• n the retirement date or the date of disability.
• If the waiver is due to a casualty, disaster or other

unusual circumstances, attach documentation such as copies of police reports or insurance company reports.

• The denial of a waiver can be appealed.

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Avoiding the Penalty

• Pay more than 25% of the

computed estimated taxes quarterly.

• Increase W-4 withholding.
• Take an IRA distribution and have

tax withheld.

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Accuracy Related Penalties-§ 6662

A penalty equal to 20% of any portion of an underpayment of tax required to be shown on a return will apply if it is attributable to one or more of the following:

• 1. Negligence or disregard of rules and regulations. (§ 6662(b)(1))
• 2. Any substantial understatement of income tax. (§ 6662(b)(2))
• 3. Any substantial valuation misstatement. (§ 6662(b)(3))
• 4. Any substantial overstatement of pension liability. (§ 6662(b)(4))
• 5. Substantial estate or gift tax valuation understatement.

(§6662(b)(5))

• 6. Any disallowance of claimed tax benefits by reason of a transaction

lacking economic substance. (§ 6662(b)(6))

• 7. Any undisclosed foreign financial asset understatement. (§

6662(b)(7))

• 8. Any inconsistent estate basis (§ 6662(b)(8))

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Negligence

Negligence includes any failure to make a reasonable attempt to comply with the I.R.C. Negligence is strongly indicated where:

• A taxpayer fails to include on an income tax return

income shown on an information return.

• A taxpayer fails to keep adequate books and records or

to substantiate items properly.

• A taxpayer fails to make a reasonable attempt to

ascertain the correctness of a deduction, credit or exclusion on a return which would seem to a reasonable and prudent person to be “too good to be true” under the circumstances.

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Disregard

Disregard includes any careless, reckless or intentional disregard.

• Careless. The taxpayer does not exercise reasonable

diligence to determine correctness of a return position.

• Reckless. The taxpayer makes little or no effort to

determine whether a rule or regulation exists, under circumstances demonstrating a substantial deviation from standard of conduct a reasonable person would

• bserve.
• Intentional. The taxpayer knows of a rule or regulation

but purposely ignores it.

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Reasonable Cause

• No penalty shall be imposed under §6662,

if it is shown there was a reasonable cause and that the taxpayer acted in good faith.

• The reasonable cause defense is not

available as a defense to penalties applied to transactions that lack economic substance.

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Reasonable Cause

• The “reasonable cause” standard draws on a broad range of

potentially applicable guidance, including the I.R.C., Treasury Regulations, the IRS’s Penalty Handbook contained in the I.R.M. (I.R.M. 20.1), and case law.“Reasonable cause is based on all the facts and circumstances. . . .” I.R.M. 20.1.1.3.2 (Nov. 25, 2011).

• “Reasonable cause relief is generally granted when the

taxpayer exercised ordinary business care and prudence in determining their tax obligations but nevertheless failed to comply with those obligations.” Id.

• Mistake,” “forgetfulness,” or ignorance of the law typically will

not establish reasonable cause and are sometimes pointed to as indicating a lack thereof.

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Common Reasons for Reasonable Cause

• Death, serious illness, or unavoidable absence.
• Fire, casualty, natural disaster, or other disturbance.
• Inability to obtain records.
• Erroneous advice or reliance.
• Ignorance of the law in conjunction with other facts and

circumstances.

• Misfeasance by employee or agent leaving taxpayer “incapacitated”
• r “disabled”.
• Financial hardship.
• Honest misunderstanding of the law.
• Uncertainty as to the state of the law.
• Reliance on erroneous information.
• Reliance on experts.

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Reasonable Cause

• Taxpayer’s education, sophistication and

business experience are relevant in determining whether the taxpayer’s reliance on the advice was reasonable and in good faith.

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Reasonable Cause Defense is Undermined

• Large unexplained discrepancy.
• Poor documentation.
• Tax-only motivated decision making.
• Chronology of events that don’t make sense
• ther than tax avoidance.
• Highly sophisticated taxpayer.
• “Too good to be true” results.
• Evidence of bad intent.
• Questionable valuations.

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Reasonable Cause

Disallowed Opinions

A taxpayer cannot rely on the opinion of a tax advisor to establish reasonable cause if the tax advisor: 1. Is a material advisor and participates in the organization, management, promoter on sale of the transaction or is related to any person who so participates; 2. Is compensated directly or indirectly by a material advisor with respect to the transaction; 3. Has a fee arrangement with respect to the transaction which is contingent on all or part of the intended tax benefits from the transaction being sustained; or 4. Has a disqualifying financial interest with respect to the transaction.

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Reasonable Cause

Disqualified Opinions

An opinion is disqualified if it:

• Is based on unreasonable factual or legal assumptions.
• Unreasonably relies on representations, statements,

finding or agreements of the taxpayer or any other person;

• Does not identify and consider all relevant facts; or
• Fails to meet any other requirements prescribed by the

Secretary.

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Reliance

• 1. Was the advisor a competent professional who

had sufficient expertise to justify reliance?

• 2. Did the taxpayer provide necessary and

accurate information to the advisor?

• 3. Did the taxpayer rely in good faith on the

advisor’s judgment?

Neonatology Assoc. v. Comm’r 115 T.C. 43 (2000), affd’d, 299 F.3d 221 (3rd

• Cir. 2002)

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Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P. Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P.

Cases

• 1. Van den Bosch v. Commissioner

T.C. Memo 2016-29

• 2. Anderson v. Commissioner

T.C. Memo 2013-261

• 3. Exelon v. Comm’r 147 T.C. No 9

(9/19/16)

• 4. Chai v. Commissioner, No. 15-653 (2nd
• Cir. 2017),

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Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P. Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P.

Qualified Amended Returns

• If an amended return is treated as a Qualified Amended Return (QAR), the

amounts of tax reported on the QAR will be treated as if they had been reported on the original return for purposes of computing the amount of tax “underpayment” unless the original return reported a fraudulent position.

• To be a QAR, the amended return must be filed before:
• The date the taxpayer is first contacted by the IRS regarding an

examination or criminal investigation;

• In the case of a promoted transaction, the date the tax shelter promoter

is first contacted concerning an IRS examination;

• In the case of a pass-through item, the date the pass-through entity is

first contacted concerning an IRS examination;

• The date a John Doe summons is served on a third party with respect to

an activity of the taxpayer for which the tax payer claimed a tax benefit; and

• The date on which the IRS announces a settlement initiative for a listed

transaction.

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Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P. Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P.

Disclosures

• Form 8275 Disclosure Statement. Taxpayers can avoid

the portions of the Section 6662, Accuracy Related penalty, due to disregard of rules or to a substantial understatement

• f income tax for non-tax shelter if the return position has a

reasonable basis. It can also be used for disclosures relating to the economic substance penalty.

• Form 8275-R Regulation Disclosure Statement.

Taxpayers can avoid the portions of the Section 6662, Accuracy Related penalty, due to disregard of regulations

• r due to a substantial understatement of income tax for

non-tax shelter if the return position has a reasonable

• basis. It can also be used for disclosures relating to the

economic substance penalty.

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Phone: 480-800-0026 Fax: 602-362-5340 jsmith@judismithlaw.com

Judi Smith is an attorney licensed in Illinois since 1995. She’s been in private practice since 2011. Her practice is focused on helping clients with international tax compliance issues. Judi has represented numerous clients with international tax issues residing in many countries including Germany, Russia, Sweden, India, and China (Hong Kong). Prior to private practice, Judi served as the In-House General Counsel and Director of Strategic Services for a multinational corporation. While there, she was responsible for domestic and international tax compliance. Judi is admitted to practice in the United States Tax Court, the United States Court of Appeals for the Seventh Circuit, the United States District Court for the Northern District of Illinois and the Supreme Court of Illinois. Prior to attending college and law school, Judi served six years in the United States Marine Corps.

FBAR History

History of the FBAR Bank Secrecy Act (1970) - only included penalties for willful violations USA Patriot Act (2001) - declared that the FBAR was instrumental in fighting terrorism. FinCEN/IRS Memorandum of Agreement (2003) - FinCEN delegated enforcement of FBAR requirements to IRS. American Jobs Creation Act (2004) - introduced non-willful penalties of up to $10,000 and increased willful penalties to the greater of $100,000

• r 50% of the transaction or balance in the account at the time of the

violation.

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FBAR Penalty Structure

• 1. Negligence. 31 USC 5321(a)(6)(A).

Only applies to financial institutions and trades or businesses. Definition of negligence: Knew or reasonably should have known of the requirement to file or keep records. See Treas. Reg. 1.6664–4. Penalty amount - Up to $500 for each negligent violation

• 2. Pattern of negligent activity. 31 USC 5321(a)(6)(B).

Only applies to financial institutions and trades or businesses. Penalty amount - up to $50,000 in addition to the $500 negligence penalty. Should only be asserted in egregious cases.

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FBAR Penalty Structure

• 3. Penalty for non-willful violation. 31 USC 5321(a)(5)(A) and (B). *

Applies to all “persons” Should not be imposed if

1. the violation was due to reasonable cause, and 2. the person files any delinquent FBARs and properly reports the previously unreported account.

In most cases the examiner will only impose one penalty per year, up to $10,000 regardless of the number of unreported accounts. Variance from the one-penalty-per-year regime requires approval of the group manager and the Operating Division FBAR Coordinator. Maximum penalty is limited to 50% of the highest aggregate balance of all unreported financial accounts for the years under examination.

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FBAR Penalty Structure

• 4. Penalty for willful violations. 31 USC 5321(a)(5)(C).

Applies to all “persons” For violations after October 22, 2004 (American Jobs Creation Act), penalty is the greater of $100,000 or 50% of the balance of the account at the time

• f violation.

The date of a violation for failure to timely file an FBAR prior to 2016 was the end of the day on June 30th of the year following the calendar year for which the accounts are being reported. Currently it is the same as the tax filing deadline (or extension deadline) for the person or entity. The date of a violation for failure to keep records is the date the examiner first requests records. Amount of penalty - see penalty mitigation guidelines.

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FBAR: Willfulness vs Non- Willfulness

IRS Definition of Willfulness (IRM 4.26.16.6.5.1) 1. The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty. 2. Willfulness is shown by the person’s knowledge of the reporting requirements and the person’s conscious choice not to comply with the requirements. In the FBAR situation, the person only need know that a reporting requirement exists. If a person has that knowledge, the only intent needed to constitute a willful violation of the requirement is a conscious choice not to file the FBAR. (emphasis added.) 3. Under the concept of “willful blindness,” willfulness is attributed to a person who made a conscious effort to avoid learning about the FBAR reporting and record keeping requirements.

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FBAR: Willfulness vs Non- Willfulness

Courts have expanded the definition of willfulness to include recklessness Courts have found recklessness where the boxes in Section III of Schedule B were checked in the years at issue or in previous years. United States v Williams (2012), McBride v United States (2012) – When a taxpayer signs their return, they are charged with the knowledge of the contents of the return, including Section III of Schedule B. United States v Bohanec (2016) – Mr. Bohanec was charged with the knowledge of the FBAR requirement because he signed a tax return in 1998 containing Section III of Schedule B. (He hadn’t filed returns since then.) The courts went on to find that the taxpayers acted recklessly by not investigating the information contained the Section III of Schedule B. By acting recklessly, they met the definition of willful

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FBAR: Reasonable Cause – Lack of Knowledge

Moore v United States (2016) - non-willful but not reasonable cause

• Mr. Moore failed to file an FBAR disclosing an account that he had

signature authority over. Once again, the court relied on the fact that

• Mr. Moore signed a tax return that contained a Schedule B to charge the

taxpayer with knowledge of their obligation to file an FBAR. James v United States (2012) – Reliance on Advice Signed a return where Section III “No” was checked. The accountant had prepared the return with the full knowledge of Mr. James foreign trust. The court deemed the preparation of the return and the “No” check box as “advice” on which Mr. James was entitled to rely.

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FBAR – Willful, Non-Willful, Reasonable

In sum, very difficult to prove reasonable cause based on lack of knowledge where the taxpayer signed a return containing a Schedule B. Willfulness = knowledge of requirement to file (based on signed return with Schedule B) plus overt action in avoiding taxation. Reasonable cause generally follows well established legal precedent.

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IRS FBAR Penalty Mitigation Guidelines

Penalties for Non-Willful (NW) Violations

Level I-NW Qualification If the maximum aggregate balance for all accounts to which the violations relate did not exceed $50,000 at any time during the calendar year, Level I – NW applies to all

• violations. See IRM 4.26.16.

Level I-NW Penalty $500 per violation, not to exceed a total of $5,000 per year. Level II-NW Qualification If the maximum aggregate balance of all accounts to which the violations relate exceeds $50,000, but does not exceed $250,000, Level II-NW applies to all violations. Level II-NW Penalty $5,000 per violation. Level III-NW Qualification If the maximum aggregate balance of all accounts to which the violations apply exceeds $250,000, Level III-NW applies to all violations. Level III-NW Penalty $10,000 per violation, the statutory maximum penalty for non-willful violations.

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IRS FBAR Penalty Mitigation Guidelines

Penalties for Willful Violation

Level I-Willful Qualification If the maximum aggregate balance for all accounts to which the violations relate did not exceed $50,000 during the calendar year, Level I-Willful mitigation applies to all violations. See IRM 4.26.16.3.6, Aggregate Value Over $10,000, above for instruction on determining the maximum aggregate balance. Level I Willful Penalty The greater of $1,000 per year or 5% of the maximum aggregate balance of the accounts during the year to which the violations relate. Level II-Willful Qualification If the maximum aggregate balance for all accounts to which the violations relate exceeds $50,000 but does not exceed $250,000, Level II-Willful mitigation applies to all violations. Level II-Willful penalties are computed on a *per account* basis. Level II-Willful Penalty For each account for which there was a violation, the greater of $5,000 or 10% of the maximum account balance during the calendar year at issue. Level III-Willful Qualification If the maximum aggregate balance for all accounts to which the violations relate exceeds $250,000 but does not exceed $1,000,000, Level III-Willful mitigation applies to all violations. Level III-Willful penalties are computed on a *per account* basis. Level III-Willful Penalty For each account for which there was a violation, the greater of 10% of the maximum account balance during the calendar year at issue or 50% of the account balance on the day of the violation. Level IV-Willful Qualification If the maximum aggregate balance for all accounts to which the violations relate exceeds $1,000,000, Level IV-Willful mitigation applies to all violations. Level IV-Willful penalties are computed on a *per account* basis. Level IV-Willful Penalty For each account for which there was a violation, the greater of 50% of the balance in the account at the time of the violation or $100,000 (i.e., the statutory maximum penalty).

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Foreign Account Tax Compliance Act

Enacted in 2010 as part of the HIRE act as an “offset” provision. Found at IRC 6038D Applicable for taxable years after March 18, 2010 Waiver for those who had to file before the form was released in December of 2011.

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FATCA Penalty Scheme

• $10,000 per year for failure to include any
• f the required information
• Plus $10,000 for every 30 days after the

taxpayer receives notice of the failure

• Not to exceed $50,000
• Reasonable Cause Abatement Available

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Facts Supporting Reasonable Cause

The taxpayer complied with tax filing and payment obligations in his country

• f residence;

They were previously unaware of their U.S. filing obligations; After discovering his U.S. filing obligations they filed their previously unfiled returns; They attached a statement to his returns setting forth their reasonable cause argument; They had a legitimate reason for maintaining non-U.S. accounts; There was no indication that they had taken efforts to intentionally conceal the reporting of income or assets; and There was no additional U.S. tax due. IRS Fact Sheet 2011-13

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Penalty Abatement Schemes

• 1. 2012 Offshore Voluntary Disclosure
• 2. Streamlined Procedures
• 3. Delinquent FBAR Procedures
• 4. Delinquent International Information

Return Procedures

• 5. Reasonable Cause

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Example Case

Year Amount on Deposit Interest Income Account Balance 2009 $1,000,000 $50,000 $1,050,000 2010 $50,000 $1,100,000 2011 $50,000 $1,150,000 2012 $50,000 $1,200,000 2013 $50,000 $1,250,000 2014 $50,000 $1,300,000 2015 $50,000 $1,350,000 2016 $50,000 $1,400,000 Example assumes 35% tax bracket and no Passive Foreign Investment Companies

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Standard Willful Penalty Calculation

Item Amount Tax ($17,500 x 8 years) $140,000 Accuracy Related Penalty $28,000 FBAR (Willful) $4,900,000 75% Fraud Penalty $175,000 Total $5,243,000

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Offshore Voluntary Disclosure

Requirements to Participate 1. Has undisclosed foreign financial assets 2. Is not currently under criminal investigation or civil examination 3. Not been notified that the IRS intends to commence an examination

• r investigation

4. Not under investigation by any law enforcement agency 5. Does not have any reason to believe that the IRS has obtained information concerning their tax liability. (N.B. With the information sharing treaties and bank requests for W9s, this is going to become more difficult to meet.)

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Streamlined Disclosure Procedures

General Qualifications to Participate for Procedures 1. Individual or Estate of Individual 2. Non-willful failure to report and pay income tax or submit all required information returns 3. No ongoing civil examination or criminal investigation for any year regardless of the issue 4. Has a valid TIN 5. Have failed to report gross income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR and/or one or more international information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) with respect to the foreign financial asset

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Streamlined Disclosure Procedures

Qualifications for FOREIGN Procedures Non-Residency Requirement: 1. For US Citizen or Lawful Permanent Resident - was physically outside the US for at least 330 full days and did not have a US abode in any one

• r more of the most recent three years for which the U.S. tax return due

date (or properly applied for extended due date) has passed 2. For non US Citizens or Lawful Permanent Resident - the individual did not meet the substantial presence test in any one or more of the last three years for which the U.S. tax return due date (or properly applied for extended due date) has passed. 3. NO REQUIREMENT TO HAVE FILED RETURNS AMOUNT OWED NO PENALTY – Only taxes, if any, and interest

70

Streamlined Disclosure Procedures

Qualifications for DOMESTIC Procedures 1. Did NOT meet the non-residency requirements 2. Have filed tax returns for the last three years (if required) AMOUNT OWED 5% Miscellaneous Offshore Penalty Taxes Interest

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Streamlined Disclosure Procedures

1. File (Offshore only) or amend the last three years of returns for which the U.S. tax return due date (or properly applied for extended due date) has passed. 2. Mark “Streamlined Foreign/Domestic Offshore” in red at the top of the first page

• f each return submitted.

3. Complete form 14653 (foreign) or 14654 (domestic).

1. Tax owed 2. Interest owed 3. Aggregate balance at the end of the year for all unreported foreign financial accounts for each of the last six years 4. Determine the year with the highest aggregate balance 5. Calculate the Miscellaneous Offshore Penalty 6. Total the tax, interest and penalty 7. Statement of non-willfulness 8. Compile the package and mail to the IRS 9. File any delinquent FBARs for the last six years

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Delinquent FBAR Submission Procedures

Qualifications to Participate 1. Have not filed one or more required FBARs 2. Not under civil examination or criminal investigation by the IRS 3. Have not already been contacted by the IRS about the delinquent FBAR(s) 4. Have properly reported and paid tax on all income from the foreign financial accounts not reported on the FBARs NO PENALTIES If the taxpayer meets the above requirements, the IRS will not impose a penalty for the failure to file the delinquent FBARs.

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Delinquent International Information Return Procedures

Qualifications to Participate 1. Have properly paid tax on all foreign accounts 2. Have not filed one or more international information returns 3. Have reasonable cause for not timely filing the information returns 4. Are not under civil examination or criminal investigation by the IRS 5. Have not already been contacted by the IRS regarding the delinquent information returns AMOUNT OWED No penalty assuming you are successful in the reasonable cause explanation

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